What are Adjusting Entries?

Definition: An adjusting journal entry is an adjustment recorded at the end of an accounting period to an asset or liability account and related expense or income accounts to record business events that occurred in the period but were not recorded. In other words, it’s an end-of-period adjustment made to record prepaid expenses, unearned income, accrued expenses, accrued revenue, and non-cash activities. All of these different adjustments arise from business events that took place in the current period but were not actually recorded in the accounting system.

What Does Adjusting Entries Mean?

Recording adjusting journal entries is one of the major steps in the accounting cycle before the books are closed for the period and financial statements are issued. According to the matching principle, revenues and expenses must be matched in the period in which they were incurred. This means that expenses that helped generate revenues should be recorded in the same period as the related revenues.

This is the fundamental concept behind adjusting entries. Let’s look at a few examples.

Example

Depreciation is a good example of a non-cash activity where expenses are matched with revenues. When a company purchases a vehicle, the car isn’t immediately expensed because it will be used over many accounting periods. Instead, it is capitalized and reported on the balance sheet.

The company will use this car to generate revenues in future periods. Thus, the cost and expense of this car should be recognized in future periods when the income is earned.

At the end of each accounting period, an adjusting entry is made to record the current year’s vehicle cost allocation by debiting depreciation expense and crediting accumulated depreciation. Without this adjustment, the current year’s income wouldn’t be matched against the current year’s expenses.

The other adjusting entries are used to adjust asset and liability accounts to match revenues and expenses in the same way.